VALUE OF A BRAND

Why acquisitions in 1980’s took place at a value 25-40% higher than Net Tangible Assets?

1980’s saw a peculiar trend of companies being valued at a much higher a price than the value of net tangible assets. In 1981, net tangible assets represented 82% of the total value of acquisitions and this number had declined to 56% by 1988. Thus, there was an increasing role being played by the intangibles not captured by the balance sheets. These intangibles were clubbed together as “goodwill” and contained a host of factors like brand value, patents, customer loyalty, employee knowledge etc. A substantial part of this was attributed or can be attributed to the BRAND VALUE. The trend led to emergence of a new financial valuation; Brand Valuation. And over the last two decades the subject has been extensively researched, models refined and several new models proposed and today, almost all big companies include this figure in their annual reports. Through this article we track the emergence of brand valuation, explain the fundamentals behind the models existing today and end with an example of brand valuation in a 21^st century company.

Brand Valuation: The History

The knowledge that a brand can be leveraged to generate revenues for a company always existed and companies often used an arbitrary mechanism to compute the future value or the strategic advantage that acquiring a brand would garner. But it was only in the late 1980’s that a series of brand acquisitions exposed the hidden value in highly branded companies and brought brand valuation to the fore. Some of these acquisitions included Nestlé buying Rowntree, United Biscuits buying and later selling Keebler, Grand Metropolitan buying Pillsbury and Danone buying Nabisco's European businesses. All these acquisitions were at high multiple price tags. Though these acquisitions gave strength to the argument in favor of Brand Valuation and also led to some research work and some modal formulation, it was only in 1988 that a figure appeared on a company’s balance sheet under the title brand value. In 1988, Rank Hovis McDougal (RHM) faced a hostile takeover bid and to counter the bid it incorporated brand value in its balance sheet. This was the first instance of the figure entering the balance sheet and soon many companies followed suit and today almost all companies incorporate these figures. Today, Generally Accepted Accounting Principles (GAAP) is on the verge of including brand valuation as a standard accounting practice.

Brand Valuations: The Methods

Over the past two decades several methods have been proposed but they can be broadly classified into three categories: The Financial Approach, The Marketing Approach and The Economics Approach.

The Finance Approach: The finance approach can further be categorized into three categories: Cost Based Approach, Comparables Approach and Premium Price Approach.

The Cost Based Approach primarily deals with valuing the brand in-terms of historical cost incurred on the brand or in some cases the replacement costs. These costs are typically advertising costs, promotional costs, marketing costs and communication costs etc. This process is not very popular as many studies have established that there is no co-relation between such expenditures and brand value. The effect of advertising, promotion and marketing cannot be captured by costs as various factors like targeting the right segment, positioning, stirring emotions, building aspirations etc go into building a brand image and hence brand value. For the above mentioned reasons this process is no longer used by firms.

The Comparables Approach is used normally as check mechanism. The approach primarily deals with valuing comparable brands to arrive at a value for your brand. But the whole motive behind building a brand is differentiation and hence comparison is not a very good method. But it is still used by some firms as a check mechanism on values obtained by other methods.

The Premium Price Approach is the most popular financial approach and the value is calculated as the net present value (NPV) of future price premiums that a branded product would command over an unbranded or generic equivalent. The approach is criticized on two accounts, one being that it does not take into account future increase in demand that a brand might be able to stimulate and second that it ignores the premium of other marketing mix elements like distribution channel etc.

The Marketing Approach: The models under this category are generally referred to as brand-equity models. They do not do any financial analysis but instead they measure the consumer’s attitude and behavior towards the brand. The measure these perceptions and attitudes of consumer and translate and relate them to consumers preference and purchasing behavior. This approach measures a large number of perceptive (aided recall, unaided recall etc.) and behavioral aspects (market share, relative price etc). These approaches are criticized as they completely ignore the financial aspects and despite high valuation from such methods, the company might still make a loss on that brand.

The Economics Approach: The most popular and most widely used method. Used in more than 4000 brand valuations today and combines both the marketing approach and the financial approach to brand valuation. It covers the marketing aspect of brands by calculating ability of a brand to generate demand, the ability to cause re-purchase, and the customer loyalty. It captures the financial by calculating he NPV of future expected earnings and the discount rate used is an indicative of risk associated with these future earnings. Given below is a simple algorithm used to calculate brand value through this method.

Step1: Segment the market in homogenous and non-overlapping segments

Step 2: Forecast revenues and earnings from intangibles generated by the brand for each of the distinct segments

Step 3: Identify various drivers of demand in each segment, and then establish the extent that the brand will affect these drivers.

Step 4: Determine the competitive strengths and weakness of a brand relative to other players and also assess the riskiness of the business environment. This helps us calculate the discount rate to be used for calculating NPV

Step 5: Calculate now the NPV of cash flows associated with this brand in each segment and discount it with the discounting rate in each segment. We then sum the NPV of different segment to arrive at the Brand Value.

Infosys: The Indian Brand

Infosys realizes that brand is an essential component of goodwill of a company and its Annual Report for 2006 cites the example of Coca-Cola whose brand value is 64% of its market capitalization. Infosys adopts a similar model as used by Coca-Cola to value its brand. The model is based on economics approach as described above and is known as brand-earning-multiple model and has several variants. The one used by Infosys is generic brand-earning-multiple model*.

We will just briefly overview the methodology used to arrive at the final figure for Brand Value of Infosys.

The first step involves all brand related earnings that a company foresees in the future. This is done by first calculating the total cash flows a company foresees in the future and then subtracting from them all non-brand cash flows. The result is then discounted to arrive at a NPV of these brand-earnings. The next stage involves restating previous year brand-profits and adjusting them for present value. We then take a weighted average of these figures and arrive at a Weighted Average of Profits. We then provide for remuneration of capital used for non-branding purposes. This figure is finally adjusted for tax to arrive at the Brand Value.